by Will Ashworth | November 1, 2012 9:56 am
The markets returned to trading on Halloween, and right out of the box, PVH (NYSE:PVH) announced it was acquiring Warnaco (NYSE:WRC) for $2.9 billion as part of its strategy to become the world’s largest apparel business.
With PVH paying the equivalent of $68.43 per share, Warnaco shareholders would receive a 34% premium to its Oct. 26 closing price of $50.88. The news sent Warnaco’s stock up almost 40% and PVH’s by 20%.
The thing is, it’s rare for both parties to experience such a jump. So what does this mean for investors?
The deal makes incredible sense for PVH. Argue all you want about the price, but it never seemed right for a company with almost $6 billion in revenue to license something as valuable as Calvin Klein jeans. Calvin Klein has approximately 60 licensing arrangements across its three brands — Calvin Klein Collection, ck Calvin Klein and Calvin Klein — with Warnaco easily its biggest licensee by revenue.
In addition to bringing the jeanswear back in-house, PVH will regain trademarks owned by Warnaco for underwear, sleepwear and loungewear. The combined PVH/WRC business will have $8 billion in revenue and two of the biggest global brands in Calvin Klein and Tommy Hilfiger.
In other words, this is a real powerhouse.
Warnaco’s strong presence in Asia and Latin America provides immediate growth outside the U.S. and Europe, where PVH’s strength lies. Prior to the deal, 7% of PVH’s estimated 2012 revenue was in Asia and Latin America; after acquiring Warnaco, that number doubles to 15%, and its North American revenue conversely falls 8 percentage points to 58% overall.
Even better, EBIT earnings in Asia and Latin America go from 13% of the overall pie to 21% –– within shouting distance of its European operations.
To be a global player in apparel, you have to operate in many parts of the world. The combination gives PVH a presence in more than 100 countries and a real opportunity to develop the emerging markets of China, India, Brazil and Mexico.
As soon as news of the deal broke, lawyers were lining up to recruit investors unhappy with the price Warnaco’s board ultimately agreed upon.
It doesn’t matter that shareholders will receive $2.12 billion in cash and 10% ownership in the merged businesses, or that its stock has achieved an annualized total return of 19.6% since emerging from bankruptcy on Feb. 4, 2003 — considerably higher than 5.4% for the S&P 500 in that same time frame.
Nor does it seem to matter to the ambulance chasers that PVH is valuing Warnaco’s enterprise value at 9 times its 2012 estimated EBITDA. TPG Capital and Leonard Green paid 8.6 times J. Crew’s trailing 12-month EBITDA in March 2011 when the two private equity firms acquired the trendy retailer.
I’m sure there’s a recent example where someone has paid more than nine times EBITDA for a decent-sized apparel company … I just haven’t been able to find one.
Fiduciary duty includes more than getting the highest price. Given their relationship, to not discuss a deal could also be interpreted as a breach of this duty.
Warnaco shareholders also should remember that CEO Helen McCluskey only took charge last December and was just beginning to work on her new strategic plan. Talks between the two companies have been on and off since 2003; they heated up once again in June when PVH chief executive Manny Chirico offered $62 a share and McCluskey countered with $69 — almost exactly where the two parties settled.
I’m not sure how she could have done better considering Warnaco was in the middle of restructuring its European operations, which resulted in an $11.3 million operating loss for its sportswear (Calvin Klein) group in the second quarter. A larger offer seems highly unlikely because both VF Corp. (NYSE:VFC) and Ralph Lauren (NYSE:RL) aren’t good fits, leaving very few realistic prospects that could manage this size of transaction.
An interesting side note to this deal is True Religion Brand Jeans (NASDAQ:TRLG).
The Los Angeles maker of premium denim officially put itself up for sale Oct. 10, and its stock jumped 22% on the news. Warnaco was considered one of the strategic buyers interested in the brand; that’s obviously not going to happen at this point. However, it does provide an interesting bet for speculative investors.
As I said previously, Warnaco’s enterprise value is nine times EBITDA. True Religion’s growth is similar to Calvin Klein’s, and its EBITDA margin is 21% — 9.4 percentage points points higher than Warnaco itself. Yet True Religion currently has an enterprise value that is just 5.3 times EBITDA, and that’s after the 22% spike.
With $6.22 a share in cash, short-term investments and no debt, an argument can be made in light of the Warnaco deal that True Religion ultimately will be sold for 7 to 9 times EBITDA, which translates to a share price of $32 at the low end and $39 on the high end. A deal appears imminent.
Chirico says it will take PVH three years to digest Warnaco, while still integrating Tommy Hilfiger. Therefore, don’t expect any more action out of PVH for at least 18 to 24 months.
While PVH’s debt load is going to double with the Warnaco acquisition, its cash flow will easily be able to pay down a good chunk over the next three years. PVH stock looks attractive below $100 and fairly valued where it sits now. If you’re a long-term investor, I’d have no concerns owning its stock.
For speculative investors, however, the play here is True Religion. Thanks to PVH putting a fire under apparel M&A, its value just went up.
As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.
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